More tax policy analysis

The new, student-run, online journal of the San Jose State University MST Program - The Contemporary Tax Journal, features tax policy analysis of legislative and administrative proposals by MST students. We expect to post these monthly to the journal website. This journal just launched in April 2011. You can see the tax policy analysis to date and the entire first issue of the journal here - http://www.sjsumstjournal.com/Focus_on_Tax_Policy.php.

I hope you will check it out.

History - Andrew Mellon on Tax Policy and Reform

A bit of history ...

Andrew W. Mellon was Secretary of Treasury from 1921 to 1932 serving under Presidents Harding, Coolidge and Hoover. He wrote a book - Taxation - The People's Business in 1924. You can find this online at the Internet Archive (I bought a copy online a while back).

Here is a quote from early on in his book, which seems pertinent today as we wonder how Congress and President Obama will not only improve our tax system, but address the unsustainable path of our federal budget.

"Tax revision should never be made the football either of partisan or class politics but should be worked out by those who have made a careful study of the subject in its larger aspects and are prepared to recommend the course which, in the end, will prove for the country's best interest.

"I have never viewed taxation as a means of rewarding one class of taxpayers or punishing another. If such a point of view ever controls our public policy, the traditions of freedom, justice and equality of opportunity, which are the distinguishing characteristics of our American civilization, will have disappeared and in their place we shall have class legislation with all its attendant evils." (page 11)

What do you think?

250 reasons for federal tax complexity

I noticed a report from the Joint Committee on Taxation issued in December 2010 that has a variety of interesting information in it. It is titled - Present Law And Historical Overview Of The Federal Tax System (JCX-51-10; 12/1/10). On page 65, there is a chart showing the number of tax expenditures in the income tax, as counted by the Joint Committee on Taxation (the definition of tax expenditures might be counted differently by others including under different political administrations - for more on that, see "Rethinking the Income Tax Calculation - A Look at Tax Expenditures," AICPA Tax Insider, 2/10/11).

Here is the chart (from page 65 of the report). Notice not only the increase in number of special deductions, exclusions and credits (about 90 in 1980 versus 250 in 2010), but also the tremendous increase just from 2006 to 2010.

This is a lot of special rules that are not crucial to defining the income tax base. These expenditures do not include the standard deduction and personal exemption as they are viewed as part of a basic income tax (to recognize that some income should be untaxed as you need it to live on). Special rules, especially so many of them, cause the following problems:

• Complexity


• Inequities


• Economic inefficiencies (non-neutral system)


• Lack of transparency as to what one's real tax rate is


• Higher tax rates

btw - Another interesting item in the report is the listing of how capital gains have been taxed since 1921 when any special treatment for them was added to the Code (pages 57 - 62).

More on tax expenditures - Minnesota report

An extensive report prepared for the Minnesota Department of Revenue in February 2011 examines the state's tax expenditures and tax expenditures in general. It defines the term, provides examples, notes problems, explains how to review them and offers recommendations for improvement.

I particularly like the statement about examining tax expenditure based on principles of good tax policy. The report notes three key principles: (1) neutrality or efficiency, (2) horizontal equity, and (3) simplicity. The authors note:

"A tax system based on these three principles would have far fewer tax expenditures than currently exist. Efficiency and equal treatment of equals both favor broad tax bases with low rates. Justified tax expenditures would include only tax provisions that offset a market failure or externality or that decrease the cost of tax administration by enough to offset lost efficiency or equity."

California SB 508 and Accountability

I am surprised and pleased about the attention being paid to tax expenditures at the federal and state levels. In California, SB 508 passed in the Senate on April 25, 2011 and was referred to the Assembly Revenue & Taxation Committee on May 9. This bill attempts to bring more accountability to tax expenditures going forward (starting in tax years after 2011). This bill would:

"authorize a personal income or corporation tax credit to contain, among other provisions, (1) specified goals, purposes, and objectives that the tax credit will achieve, (2) detailed performance indicators to measure whether the tax credit is meeting those goals, purposes, and objectives, and (3) a requirement that the tax credit cease to be operative 7 taxable years after its effective date, as specified."

I think this might also have the effect of sometimes causing the credit not to be enacted in the first place. That is, in writing up the purpose of the credit and how they can be measured, I think there would be better discussion as to whether such goals are appropriate and whether alternatives including direct funding would be better.

Some unfortunate limitations with the current bill:

• Why does it only address credits in the personal and corporate income tax? Tax expenditures also come in the form of deductions and exclusions.
• Why only income tax expenditures? Tax expenditures can also exist in any type of tax. They exist anytime there is a special rule that is not crucial to defining the tax base and tax calculation. For example, the sales tax exemption for food is a tax expenditure.
• Why the 7-year sunset that appears to be unconnected to the assessment results? Why not just provide that the legislature must annually review the assessment data (or perhaps every two years) and if the goals are not being met, the credit expires the next year? The Senate floor analysis (4/13/11) notes this opposition: "Some opponents to this bill state that mandatory sunsets for tax expenditures are inappropriate and unfair when similar requirements do not apply to spending programs. Others state that the seven year standard is arbitrary; while sunset provisions and performance review are important, a firm's investment horizon and the tax credits themselves vary from case to case, and the same, fixed sunset period should not apply to tax incentives which may require different periods of time to accomplish its purposes." I agree with this except that direct budget items arguably do get scrutinized in each annual budget cycle. The legislators should be trusted to be able to evaluate the credit assessment data and act accordingly. Public oversight of this, particularly by the press and public interest groups will make it difficult for the legislators to continue a credit when the assessment data says the credit is not meeting its stated goals.

The Senate Committee analysis (3/24/11) has a good discussion of perceptions on tax expenditures including whether the attention is wrong because it ignores the view that taxpayer money belongs to them. I don't agree with that perspective. For example, when Jane claims a mortgage interest deduction on her second home, other taxpayers pay for that benefit. That is, instead of the mortgage interest deduction on a second home that benefits a few people but results in reduced tax collections for the government, there could instead be lower rates for everyone or a higher standard deduction for everyone.

The analysis also includes an entertaining example which I noted in a 3/29/11 blog post - here.What do you think?

Taxing Services - More Reasons and Support

I came across a short report issued by the Morrison Institute for Public Policy at Arizona State University entitled, "Taxing Services: Arizona's Untapped Revenue Resource" issued in February 2011. It points out, as others have also pointed out, that there are equity reasons for broadening the sales tax to include personal services. It also notes that such expansion would also modernize the sales tax to reflect today's consumption and products. It states:

"However, if ever Arizonans faced a time where necessity should drive invention, this is it. Further, expanding the tax to consumer services would not only provide critical revenue, it would also more accurately reflect the current economy and increase predictability and responsiveness of the tax system — two key components of successful revenue systems."

The report also notes that taxing services is just one aspect of the total tax system that needs to be reviewed.

For more information on modernizing the sales tax to reflect today's ways of living, please see my prior reports and op eds - here. Broadening the base would help the sales tax to better meet principles of good tax policy and modernize this 1920's/1930's Depression-era tax. And ... the high sales tax rates can be lowered, further improving the tax system.

What do you think?

Governor Brown Proposal to Improve CA Sales Tax

California Governor Brown's current budget proposal includes a manufacturing sales tax exemption (pages 11 and 31). New businesses would get a maximum 5% exemption while others would only get a 1% exemption. The 5% represents the state level sales tax (the balance of the tax is for local governments. This change eliminates pyramiding of the tax and helps California to be more competitive with other states that offer such a sales tax exemption (although other states have exemptions that apply fully to all manufacturers).

The governor proposes to pay for the exemption by mandating that all companies apportion income using the single sales factor (rather than choosing between that and the double-weighted sales, 3-factor apportionment approach each year.

This is a start towards a better sales tax in California. Certainly, more is needed, most notably a lowering of our high sales tax rate and broadening of the base to include more types of personal consumption.

S. 940 - Close Big Oil Tax Loopholes Act

There is a lot of press attention on the Senate vote of May 17, 2011 on S. 940 - Close Big Oil Tax Loopholes Act. The Senate did not get the required 60 votes (52-48) to continue with the bill. The Congressional Research Service (CRS) summary of this bill:

"Amends the Internal Revenue Code to deny to oil companies with gross receipts in excess of $1 billion in a taxable year and an average daily worldwide production of crude oil of at least 500,000 barrels a year: (1) a foreign tax credit if such company is a dual capacity taxpayer, as defined by this Act; (2) the tax deduction for income attributable to domestic production of oil, natural gas, or primary products thereof; (3) the tax deduction for intangible drilling and development costs; (4) the percentage depletion allowance for oil and gas wells; and (5) the tax deduction for qualified tertiary injectant expenses."

So, "big oil" means more than $1 billion of gross receipts.

Talk of reducing the corporate tax rate in a revenue neutral manner as President Obama has suggested, will mean that favorable tax rules that are not key to defining taxable income will need to be reduced or repealed. This includes those for large oil companies. Percentage completion is not needed to measure taxable income (just regular depletion is needed), so it could be repealed. Why the difficulty in repealing unnecessary tax expenditures? (I don't call them loopholes because these provisions are being used as intended. Typically, the term "loophole" is just used to help sell the public on the idea that these are bad provisions.)

Possible reasons:

• There is some illusion that we can lower tax rates without removing or reducing tax expenditures. I don't think the public will buy in on this, particularly when it comes to corporations. I don't see how it will improve our budget problems.


• Congress wants to just have one bill that lowers the corporate rate and includes all of the tax expenditure reductions for all businesses rather than have piecemeal bills. This is a good idea. So what was the point of the grandstanding on this oil tax break bill? Sounds like a waste of time to me and it plays on the reality that people don't see that ultimately all taxes are paid by individuals. Higher taxes for oil companies will mean less return for investors, or wages for employees or higher prices for customers, or some combination of all of these things that will affect individuals.

I don't think there is any positive value in using public concern over higher gasoline prices with a limited effort to reform the tax law. [For some of the rationale for S. 940, see this excerpt from the Congressional Record of May 16, 2011.]

What do you think?

Four Years of Blogging!

I started this blog May 14, 2007. Some of the first topics I posted were about weaknesses in the California sales tax, such as the base being too narrow and the use tax gap. So, what has changed?! Well, the California sales tax rate is 1 percentage point higher today (and a few more weeks). This is unfortunate. It would be better to broaden the base and lower the rate and start phasing out the application of sales tax to business purchases.

The use tax gap exceeds $1 billion per year. Changes in the last four years are minimal in effect in closing this gap. A requirement for businesses without a seller's permit, and at least $100,000 of annual gross receipts to register was added, but I'm not convinced the cost-benefit is there. Instead of creating a new filing regime, there are ways to better enforce the requirement to pay use tax on your income tax form. Improvements there include mandating that anyone who does not file a quarterly sales tax report to have to enter a number of the income tax form use tax line. The "look up" table to be added starting for 2011 tax returns will help because if anyone doesn't keep records of how much use tax they owe, they can just use the lookup table to get figure (3/19/11 post).

But, we still need a lot more education about the existence of the use tax, a more clear line on the Form 540 and instructions, as well as public information on the benefits of lowering the rate and broadening the base.

I'm sure the sales tax topic will continue to show up in this blog. I expect though that the fifth year of this blog will be focused more on federal tax reform and moving our tax systems into the 21st century and reforming them to better meet principles of good tax policy. Congress has held several hearings on tax reform this year and we are expecting a reform proposal from President Obama. Should be plenty to blog about!

Thank you for reading and commenting! I hope you continue to do so!

State Tax Expenditures and CBPP Report

The Center for Budget & Policy Priorities has released a report - Promoting State Budget Accountability Through Tax Expenditure Reporting (May 2011). The report notes features of various state tax expenditure reports and what features should be in them to make them of most use to policymakers, the press and others. The report also includes some helpful reminders and observations such as:

• Tax expenditures are not examined regularly as are direct budget items.
• When there are no sunset dates that would require some discussion on whether the special deduction, exclusion or credit should be renewed, and no special data collected or made available to lawmakers, an element of spending easily continues even if it is not effective.
• "if policymakers, the media, and the general public lack information about tax expenditures, they cannot fully participate in decisions about how to allocate state resources. In fact, in many states the policy debate encompasses little more than half of the state’s total expenditures because expenditures made through the tax code are not part of the conversation."

Some of the improvements the CBPP suggests include:

• Have sunset dates for tax expenditures.
• Create a performance review process for tax expenditures.
• Set a maximum cost for tax expenditures.
• Set accountability measures for taxpayers that claim economic development tax incentives.

These are useful suggestions for states and the public. I think if the public and the press had better information on tax expenditures, more questions would be asked. Tax expenditures can grow with no oversight to catch it. In 2009, some Oregon lawmakers observed that the cost of its roughly 380 tax expenditures was greater than spending on education, health care and public safety combined (8/19/09 post). I think the public would be shocked at that. I think they would also be shocked at the spending on housing and education in the tax law.

I'd like to see a report with the tax expenditures included in the budget by function. So, the tax expenditures for housing would be itemized and included in the budget for the housing agency (such as Health and Human Services Department). Then that should be broken down to show the use of the funds among the income quintile groups.

What do you think?

More on who benefits from tax expenditures

The talk about the $1.1 trillion of tax expenditures in the federal income tax system continues. An op ed blog in the Christian Science Monitor on May 7, 2011 by Howard Gleckman of the Tax Policy Center* contrasts the report that half of individuals pay no income tax to who benefits from the $1.1 trillion of tax expenditures. He notes that the tax expenditures - special deductions, credits and exclusions that are not crucial to defining the income tax base, provide a greater tax savings to higher income individuals.

He states, based on Tax Policy Center data, that the tax expenditures (including the lower capital gains rate) are ...

"worth about $1,000 to a typical household earning about $21,000 or less (the bottom 20 percent).... Middle income households earning between $40,000 and $70,000 get an average of about $4,000.... The story is very different at the top of the economic food chain. Those tax breaks are worth an average of $275,000 to those in the top 1 percent (who make at least $668,000) and $1.5 million to those in the top 0.1 percent (who make more than $3 million)."

So he suggests that we should not just look at the tax savings of the half that don't pay any federal income tax, but also the savings of those at the top of the income list.

A good reminder that there are many aspects to look at in tax reform. Additional ones that come to mind for me include:

• The need to look at all federal taxes, not just income taxes.


• The reality that a multitude of special rules reduces transparency making it difficult to know your actual tax rate. Such rules also increase complexity and economic inefficiencies.


• Differences between deductions and exclusions (worth more to those in higher tax brackets) versus credits (worth same to everyone).


• How progressive should the federal income tax be?

*See "Who pays no income tax? It is the wrong question" by Gleckman.

What do you think?

California Oil Severance Tax, AB 1326 and Our Troubled Budget and Tax Systems

An editorial from NBC (5/5/11) on another proposal for an oil severance tax in California caught my attention and I posted a comment there. The proposal, AB 1326, calls for a 12.5% oil severance tax in California. Most states have such a tax and California does not.

The tax is justifiable for a few reasons - it is an appropriate charge for extraction and California has an ambitious goal to reduce greenhouse gas emissions.

I find the problem with the proposal is that the tax is earmarked to fund higher ed by establishing the California Higher Education Endowment Corporation (CHEEC) to handle allocation of the funds among California's three higher education institutions. Why? Do we need another bureaucracy? We already have bodies to oversee higher education budgets - the legislature and the Boards of Trustees of the three higher education institutions.

Unless a tax has a direct connection to an activity, such as is the case with gasoline excise taxes to fund highway construction and maintenance, taxes should to into the General Fund (GF). The GF should then be used to fund programs that benefit the public, such as education - both K-12 and higher education.

But, part of the reason for the AB 1326 approach, I believe, is to get around the Prop 98 rule that a specified portion of the GF goes to K-14. So, we are creating a new problem to address an old problem - where does it end?

We would never tolerate this type of budget restrictions on ourselves. For example, would you live with a requirement that the money you make on Monday goes for rent, Tuesday's goes for food and entertainment, Wednesday's goes for retirement funding, etc.? So, if you need more money for rent, you can't dip into earnings from another day, you'd just have to get a better paying job or a second job for Monday. Or, if your earnings for one day goes down, you'd have to spend less on that day's allocated expenditure. That's odd, but that is the California budget system.

If Prop 98 is leading to more oddities of budgeting, let's fix that. There are other mechanisms to ensure that what we want funded gets funded. We learned about that in 8th grade civics class.

And another bureaucracy is created to be sure the oil companies do not pass the tax along to consumers. Well, corporations are just entities - ultimately, all taxes are paid by individuals. Taxes paid by corporations are paid by some combination of customers, employees and investors. So, AB 1326 is saying that the severance tax should be paid for by employees and investors. Seems odd, but worse yet, a mechanism is put in place to be sure that happens. Here it is:

"The tax imposed by this part shall not be passed through to consumers by way of higher prices for oil, natural gas, gasoline, diesel, or other oil or gas consumable byproducts, such as propane and heating oil. The board shall monitor and, if necessary, investigate any instance where producers or purchasers of the oil or gas have attempted to gouge consumers by using the tax as a pretext to materially raise the price of oil, natural gas, gasoline, diesel, or other oil or gas consumable by products, such as propane and heating oil."

It appears that the "board" is the same one that oversees allocation of the tax revenues. And, while some people might think it is investors who should pay, those investors include retirement fund and mutual fund investments of ordinary citizens (not just billionaires).

Obviously, this all hits a strong chord for me - it is just so convoluted and unnecessary. Let's fix the system rather than make it more complicated, non-transparent and illogical.

What do you think?

Taxing Businesses and the Challenge of Lowering the Corporate Tax Rate

Talk of lowering the corporate tax rate seems to sometimes ignore the reality that most businesses operate outside of the corporate form. That is, they are sole proprietors, partnerships, LLCs or S corporations. For recent data, see this chart from a recent article of mine from the AICPA Corporate Taxation Insider, "The Journey to a Lower Corporate Tax Rate," 3/24/11. The bulk of gross receipts though are generated by C corporations (chart). That makes sense when you think about the Fortune 500 where even the 500th company has revenues of $4.1 billion. Think about most small businesses - many under even $200,000 of revenues.

But, lowering the corporation tax rate is not easy for a few reasons including:

1. For revenue neutrality, as required by President Obama and others, some tax breaks will go away. However, the deductions often noted for repeal are not used only by corporations. These include the Section 199 manufacturing deduction, lower-of-cost-or-market inventory valuation and LIFO.


2. Once the corporate tax rate is reduced, some businesses will likely shift to C corporate form if it lowers the income. This would include sole proprietors and passthroughs with income levels that get taxed at the individual top rates (particularly when this goes back to 39.6% after 2012). This happened after the Tax Reform Act of 1986, only in the opposite direction. That is, when the individual rate dropped below the top corporate rate, there was a tremendous growth in S corporations (chart). How will this affect the revenue estimates and how low the corporate rate can go?


3. Discussions of lowering any tax rate often lead to questions (a good thing) about just how the system really works today. At recent hearings in the tax-writing committees on tax reform, it was noted that some businesses are quite large, but are not C corporations. Comments were made that perhaps all or more businesses should be taxed as C corporations. As I noted in a 3/24/11 post, that led Senator Snowe to introduce S. Res. 88 saying that businesses should be free to select their own entity form. A May 1 article by Reuters - "U.S. mulls making more firms pay corporate tax" notes that President Obama is considering taxing businesses with gross receipts over $50 million as C corporations. That means that all of the business income would be taxed at ordinary rates (no lower rate on capital gains), double taxation, different rules for contributions, and a few other differences. The article says that a formal proposal is forthcoming. So, a plan to lower the corporate tax rate might look a lot different than originally expected.


4. Will the public buy in? Articles about very low effective corporate tax rates likely don't sit well with the public. See my 4/5/11 post.


5. Will a lower corporate tax rate require the 2001/2003/2010 tax cuts to be made permanent? If yes, how will it all be paid for?


6. Is a lower corporate tax rate the solution to the problem? What is the "problem"? The US tax system is out-of-date relative to other countries in several ways including its worldwide tax system (rather than territorial) and double taxation of corporations. Also, other countries with the lower corporate tax rates have a national VAT. Does the existence of the national VAT enable a lower corporate tax rate? Does the fact that a VAT is border-adjustable help other countries (that is, the VAT is owed on imports, but not exports)? Wider tax reform discussion is needed if we are really going to move our tax system into the 21st century!

What do you think?